Let’s discuss federal gift taxation for 2012.
Our government has been fairly active lately initiating proposals for gift taxes in 2013 and beyond. For example, earlier this month, President Obama proposed the application of the gift tax rules that were in place in 2009. Since this would result in a higher gift tax rate (up from 35% to 45%) and a lower lifetime exemption (down from $5.12 million to $1 million), it is probably worth taking a few minutes to further understand exactly what is involved.
Common recommended estate planning strategies, such as gifting as much as possible while you can before 2013, are beyond the scope of this post. Instead, we’ll cover the main rules in effect now and also apply them to two somewhat common scenarios.
Gift Tax Rules
These rules apply to “inter-vivos” gifts (i.e. made during a person’s lifetime) only, whereas estate taxes apply to gifts made after death.
- The federal gift tax is imposed on property transferred by gift by U.S. residents or non-residents. 26 U.S.C. § 2501(a).
- The tax is paid by the gift’s donor. 26 U.S.C. § 2502(c).
- The tax is applied in each year the donor gives away property.
- Calculation – The gift tax is equal to the gift tax rate multiplied by the amount of “taxable gifts” made during the calendar year. 26 U.S.C. § 2503(a).
- In 2012, the maximum gift tax rate is 35%.
- To calculate “taxable gifts”, take the total amount a donor has given in a calendar year and reduce it by the following:
- Lifetime Exemption
Several items are excluded from the definition of “gift”, which results in most citizens or residents never having to pay the gift tax:
- Annual Exclusion
- In 2012, the first $13,000 of gifts to any individual are not subject to gift taxes. See 26 U.S.C. § 2503(b).
- Qualified Transfers for Educational or Medical Expenses
- Qualified Transfers are also excluded from the calculation.
- A qualified transfer is any amount paid on behalf of another individual (the “donee”):
- As tuition to an educational organization for the donee’s education or training.
- To a person who is directly paid to provide the donee with medical care. 26 U.S.C. § 2503(e).
Additionally, all U.S. citizens and residents are permitted a lifetime gift tax credit.
- In 2012, the first $5.12 million of lifetime gifts above and beyond the exclusions stated previously are exempt from gift taxes. 26 U.S.C. § 2505(a).
An individual’s lifetime credit is reduced each time he or she makes a taxable gift. Depending on the size of the donor’s gift(s), the credit can be used up in one calendar year or in multiple years. See Example 2 below.
Finally, the following may be deducted from the donor’s total gifts:
- Gifts to Charity – 26 U.S.C. § 2522 details the differing rules for U.S. citizens, residents, and non-residents. .
- Unlimited Marital Deduction – In general, any gift to one’s spouse is fully deductible for gift tax purposes. 26 U.S.C. § 2523 explains when and how this rule applies, and includes the rules for gifts of life estates, joint interests, and charitable remainder trusts, as well as the limits where the donor’s spouse is not a U.S. citizen.
To hopefully illuminate all of that, here are two examples that further explain the concepts:
- Example 1 – A married couple has 3 children, and pay the following in 2012:
- They buy presents for each child for their birthdays and holidays. The total values of the gifts to each child do not exceed $26,000.
- They cover all of their children’s medical expenses by paying the doctor directly at the time of each visit.
- They pay college tuition directly to their first child’s university.
- They pay private school tuition for their other 2 kids directly to the school.
- The wife directly transfers $500,000 of mutual fund assets to the husband’s account to equalize the amounts in their estates.
- Result– No gift tax is owed.
- The couple’s $13,000 annual exclusions can be combined if joint gifts are made.
- They make qualified payments to doctors and schools.
- The wife’s gift qualifies for the unlimited marital deduction.
- Example 2 – A widower, W, has a $9 million estate and decides to live more simply. He wishes to immediately give $1.5 million gifts to each of his 4 children. He previously reported a $1 million gift to his brother in 2005 but paid no gift tax at that time.
- Result – W would owe approximately $616,750 of gift taxes in 2012, calculated as follows:
- Annual exemption – The $13,000 annual exemption would apply to each child’s gift, so $1.487 million of each child’s gift would be subject to gift tax.
- The four gifts would total $6 million, $5.948 million of which is taxable, and must be reported to the IRS.
- Prior Gift
- In 2005, the annual exemption was $11,000. Therefore, $989,000 of W’s gift was subject to gift tax that year.
- This amount is deducted from W’s lifetime exemption amount of $5.12 million.
- Therefore, entering 2012, W had $4.131 million of his lifetime exemption remaining.
- W’s $5.948 million in 2012 gifts less $4.131 million of his lifetime exemption equals $1.817 million of taxable gifts. Using the 2011 gift tax tables for this $1.817 million results in the $616,750 gift tax stated above.
- NOTE: A big thank you to Zachariah White from The Math Forum @ Drexel University for correcting my calculations.
Of course, real life is usually much more complex. However, in addition to applying the rules stated above, these examples hopefully illustrate that while most will not owe any gift taxes in 2012, a greatly lowered lifetime exemption in 2013 and beyond could necessitate some changes in your plans.
Questions or Comments
Please comment below. Thanks for stopping by!
- 5 Gift Tax Myths Addressed (lawprofessors.typepad.com)
- Obama’s 2013 Budget and Estate Taxes – Same Thing, Different Year (wills.about.com)
- IRS Releases Publication 950: Introduction to Estate and Gift Taxes (sofloridaestateplanning.com)